In this article, Deloitte's Gavin Bullock looks at the implications for investment managers of the Government's consultation on the structure of Local Government Pension Schemes.

On 1 May the Government released a consultation in respect of the structure of Local Government Pension Schemes (LGPS) and opportunities to reduce administration and investment management costs. The proposals set out a number of recommendations, which could have a major impact on the asset management industry given the £178bn of assets currently under management by the LGPS. At this stage, the consultation envisages annual savings of £660m.

The package of proposals include:

  • Establishing common investment vehicles (CIV) to provide funds with a mechanism to access economies of scale, helping them to invest more efficiently in listed and alternative assets and to reduce investment costs.
  • Significantly reducing investment fees and other costs of investment by using passive management for listed assets, since the aggregate fund performance has been shown to replicate the market.
  • Keeping asset allocation with the local fund authorities, and making more transparent and comparable data available to help identify the true cost of investment and drive further efficiencies in Schemes.
  • A proposal not to pursue fund mergers at this time.

This could fundamentally change the way local government pension schemes invest their assets in the future, and particularly their use of life funds. The consultation also opens up the debate on the relative merits of passive vs. active management, and based on our recent work with local authorities who are considering setting up such vehicles, there are very diverse views on this topic.

Potential benefits for LGPS – reducing fees

The consultation suggests that a move to passive investment could save £420m annually, comprising of a reduction in investment fees of £230m, and reduced transaction costs of £190m. This has already been a topic of conversation as the London boroughs have been exploring establishing a CIV, and the expectation is that some investment managers would be willing to reduce fees.

Further, by changing the way the LGPS invest into alternative assets, with a shift from fund of fund arrangements to a separate CIV, the consultation document envisages annual savings of £240m. 

Overall, economies of scale, improved efficiency, and reduced costs are expected, whilst each LGPS will preserve local control over asset allocation.

Implications for the industry

There is £178bn of LGPS assets under management currently, split between a large number of managers, across different asset classes and both passive and active strategies.

Establishing a small number of large CIVs will consolidate these assets to a much smaller population of suppliers. As such, over time LGPS assets may move out of current mandates, into CIV mandates.

Managers will need to consider what products may be attractive to the CIV, and whether pooled funds or segregated mandates might be more preferable. It is possible that investment products the CIV could be interested in using will differ to those that LGPS currently invest into. Any solution would need to retain the withholding tax benefits the LGPS currently are entitled to if they invest directly into the underlying assets.

Next steps

Groups with significant LGPS investment should consider how this may impact them, and what options are available with regard to future LGPS investors.

It will be some time before the results of the consultation are known. It will close on 11 July 2014. The Government will publish its response in due course (at this stage no date has been announced). Should any legislative changes be required, a further consultation will also be undertaken. That said, the London boroughs began a process to establish a CIV earlier in the year, and we expect this will become an increasingly important consideration when seeking to attract LGPS investment.

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